Episode 28: How We Test Investing Strategies
Joe and Ryan talk about the importance of testing and how they approach testing different strategies across the Graceada Partners portfolio.
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Ryan Swehla:
And, going back to that submarket conviction, we bought 1651 Response Road, March of 2020.
Joe Muratore:
Yeah.
Ryan Swehla:
And it was 35% occupied.
Joe Muratore:
Yeah.
Ryan Swehla:
Right before COVID. So this is like, poster child. It's an office product. And today it sits at 82% occupied.
Joe Muratore:
Yeah. Wow.
Ryan Swehla:
And little more than a year after.
Speaker 3:
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Joe Muratore:
Let's talk about this idea in business of testing and then making big bets. So Jim Collins calls this bullets and then cannonballs, the idea of when you're trying something new, first attacking little pieces, and then choosing to make that big bet. And he points out that great companies, you can't get there on bullets. You have to make those big bets. So let's talk about how we developed some of these themes, some of the bullets we've shot, some of the cannonballs we're shooting.
Ryan Swehla:
Yeah. And how that relates to our real estate practice.
Joe Muratore:
Right.
Ryan Swehla:
Because this idea of testing and then going big has a lot of implications for how we invest in real estate.
Joe Muratore:
Right. With every property we buy, we often test something new, a slightly different submarket. We move, slightly different geography. We try a slightly different investment strategy, and we'll talk on some of those. But the goal is to know which bullets to shoot when, and to have multiple strategies, so that when you see an opportunity, you aren't seeing it through one lens. You can see it through multiple lenses to get to value, especially in a competitive world where if everyone sees everything the same way, you're not getting to Alpha.
Ryan Swehla:
And if you're using the same strategy, the same approach, the same geography, the same product type over and over again, you're going to expose yourself to risk.
Joe Muratore:
Right. Some of the bullets we've shot in Sacramento have been the Point West submarket, the North Natomas submarket, the Folsom submarket, the Pocket submarket, now Carmichael. But we've been nimble in that we shot office bullets, and then we went with, maybe we'll call it a cannonball and in multifamily in the Pocket.
Ryan Swehla:
Yeah. Yeah.
Joe Muratore:
And now we're doing another large apartment complex in Carmichael. And now we're doing some industrial, right in the middle of all that. So we're trying different ideas.
Ryan Swehla:
So you mentioned the Point West submarket. There's a good example where we did bullets and then cannonballs. We started with one property, 1651 Response Road. We had the conviction around the idea that this submarket would be beneficial as the downtown continues to heat up. And then post-COVID, as people rethink the downtowns and also look to those immediate periphery outside, because the Point West submarket is right outside downtown Sacramento. And...
Joe Muratore:
We also like the free parking. We like the more garden style. That proved to be a great play. So we first bought 1651 Response. And then we bought 1451 River Park.
Ryan Swehla:
And now we're looking at an even larger acquisition in that market as well.
Joe Muratore:
But some of the themes we saw there were, the first bullet was testing the submarket, 1651 Response, which is now about two thirds, at least. What we learned with that is construction costs. Even though we bought it at $76 a foot, the whole building, construction costs are expensive, and downtime, thanks to COVID, was longer than we expected. So we adjusted and we shot a different bullet next time. We said, "Hey, we're getting close to filling this building. That park has worked really well. With our next bullet, how can we avoid this construction cost risk?" So we went to 1451 River Park. 75% occupied, bought it at about an eight cap, substantially already a great building in a great spot. And we just had to fill in some of the spaces. So, repainted the building, redid the landscaping, we've signed four or five new leases since buying it. What did we learn? We like the submarket, let's mitigate some of our construction costs. We can still get to a similar return.
Ryan Swehla:
And going back to that submarket conviction, we bought 1651 Response Road, March of 2020.
Joe Muratore:
Yeah.
Ryan Swehla:
And it was 35% occupied.
Joe Muratore:
Yeah.
Ryan Swehla:
Right before COVID, so this is like, poster child. It's an office product. And today it sits at 82% occupied, little more than a year after. So clearly the conviction around that market worked, and that's we have made additional investments in that submarket.
Joe Muratore:
Yeah. We look to grow with that submarket. That leads us probably to Folsom. We bought 785 Orchard, right in the Folsom submarket. Actually closed about a week ago. The great news is, we...
Ryan Swehla:
We had conviction around it, and...
Joe Muratore:
The good news is, we bought it about 92% occupied at $172 a foot. Today it's 100%, right on the verge of being 100% full. We're working on the last lease.
Ryan Swehla:
So there we shot a bullet, and we kind of wish we shot a cannonball, but at the same time that bullet has validated that that is a market that we should be more active in. In escrow, we managed to fill the building.
Joe Muratore:
Right. So on the office side, we went from a conviction around deep value add to a more mild value add. And I think that's going to influence us as we go forward. So we're...
Ryan Swehla:
Maybe we can talk a little bit about multifamily, and how we're using bullets and cannonballs in that area.
Joe Muratore:
Right. Well, so 1651 Response, turned out the seller there owned a large multifamily project in the Pocket. And we were able to buy that at $155,000 a door. We're about to go to market with it at a much higher price. This last year has seen incredible growth. So that was a little bit of a bullet and a cannonball at the same time. But since then, we learned from that. We bought The Edge in Modesto, 196 units. We're currently buying Carson Aire, 175 units and just outside Carmichael. So what's interesting about that is, the bullet we shot in the Pocket was high demographic, pretty strong value add, and that's worked out really well. The one in Modesto was a little bit lesser demographic, a little bit less of a value add, but we had a conviction around the future of, of Modesto and apartment growth. And both of those have gone extremely well.
Joe Muratore:
With Carson Aire, it qualifies as workforce housing. This is a lower median income in the area, but we're in it at $136,000 a door, which for Sacramento is, I don't see it anymore. So in all cases though, there's room to run on the rents, and in some cases we have to do a fairly strong, say $10,000 per door, or in the Pocket, $18,000 per door, lift to get those new rents. But in some cases it's less, like The Edge in Modesto.
Joe Muratore:
So currently I'm working on a great heat map that maps out the fastest growing markets and fastest growing submarkets in Northern California. We have 113 in our trade area and I have them all ranked by which ones are growing the fastest.
Ryan Swehla:
Don't tell.
Joe Muratore:
I'm going to tell. But the trick with this heat map is marrying up rent growth with per unit cost, so where's the greatest delta in value? But there's this other key point, which is, in a sense, I think that everything moves towards replacement cost, and to where you can see the gap between replacement cost and current pricing, and then factor in a piece of value for age and quality of the structure. If we can layer on the greatest gaps there too, that also adds when do our sales. But...
Ryan Swehla:
And so right now, without naming a submarket, I know you're very actively looking in the number one market through that ranking.
Joe Muratore:
And it's not a market I would've picked. But it makes sense. And so the trick here is using data to see the world through new eyes, where the crowd is saying, "More into Sacramento, more into Sacramento," or wherever, our job is to see beyond that, to see the breadcrumbs, see the data, and then go validate that and back that up and shoot bullets, and then cannonballs.
Ryan Swehla:
Yep. Start with bullets and then move to cannonballs.
Joe Muratore:
We're doing that with office buildings too, and we're doing that in industrial a little bit as well.
Ryan Swehla:
Yeah. Well, in 915 B Street, we talked about that on an earlier episode, but there's an idea of a true value add within industrial, where we're achieving what we believe are appropriate value add returns, and a strong conviction around that investment. But we'll see how it plays out. We believe that the merits of the investment are there, but by testing that, it opens up a whole new world. And when we see how that works, it allows us to then take that lens and look across our market for other opportunities that fit that criteria.
Joe Muratore:
I'd say the bullet there, the asset stands alone as an industrial property where rents can be raised. That's not particularly the bullet. The new thing there is layering on the macro and micro economics of the region. So on the macro side, Sacramento has been a winner post-COVID. There's been tremendous movement from the Bay Area. And on the micro side, this building happens to be right in the Rail Yards District, right in an area where a tremendous amount of development is happening. Luckily, again, the building stands alone. We were able to make this bet clear-eyed with the building by itself. But what we're testing is in a three to five year hold period, how much is the micro, the macro microeconomics surrounding this building going to put additional wind in our sails? That will translate from it being a double or a triple to a home run.
Ryan Swehla:
Yeah, absolutely. So I think closing out on this thing maybe a little bit is, that there are, within our real estate practice, there are a lot of ways that we can test the market, and test the market means markets, it means submarkets, it means strategies, it means particular approaches to how we add value. And that not only makes good sense from a risk mitigation standpoint, because we're diversifying, but it also brings some joy and challenge and interest to what we do versus same thing every single day.
Joe Muratore:
Oh, yeah.
Ryan Swehla:
And employing the same strategy. And it's a margin of safety for business as we grow.
Speaker 3:
Thank you for listening to Durable Value, an investors' podcast, where we demystify commercial real estate with safe, sound investment strategies to help you balance your portfolio. If you enjoyed this podcast, be sure to rate it on iTunes, or wherever you get your podcasts. To learn more, visit Graceadapartners.com, where you'll find more information, investors' tools, case studies and more. This podcast is hosted by Joe Muratore and Ryan Swehla. It's produced, edited and mixed by Melodic, with intro music by Ian Post. Thanks again for listening, and we'll see you next time.